If you were to suggest to colleagues or clients that the biotechnology sector presents a good opportunity for investment, they might very well respond with a shrug. There are plenty of less risky ways to make money. Those folks would have a point. If you’re not participating in biotech, however, you’re missing out on the next major wave of technological innovation and the resulting opportunity for returns.
Consider these points:
- Biotech has outperformed the general markets in both the second and third quarters of this year by a factor of three. The CBT200 (the Centient Biotech 200 Index, our proprietary list of selected biotech stocks on U.S. exchanges) rose 20.4% while the NYSE was up 6.5% and Nasdaq 7.6%.
- Biotech has replaced pharmaceuticals as the source of health care innovation.
- Biotechs created 20 new drugs last year, while big pharma produced 11.
- Biotech is on a long-term up trend, driven by an aging population and rapidly advancing science.
There’s another reason to invest in biotech: “To do good while doing well.” One of the benefits of investing in biotechnology is that you are contributing to the success of companies that are striving to extend patients’ lives and find cures for deadly diseases such as cancer. Advances are made nearly daily, and by investing in biotech you are contributing to that progress while pocketing some profits.
While there are many opportunities to profit from unfolding technological and scientific advances, biotechnology is a complex, high beta industry. As such, advisors should be armed with some basic knowledge and principles before they invest client funds in biotech.
What Is Biotech?
The term “biotechnology” was coined in 1919 by the Hungarian engineer Karoly Ereky to define the concept of products made “from raw materials with the aid of living organisms.” But it wasn’t until April 1976 that the first biotechnology company–Genentech–was formed. Prior to that, all drugs were developed from chemical compounds, often discovered in unexpected places like the soil or insect secretions.
Since biotechnology-based drugs, or “biologics,” must literally be grown from something living, they are much more complex to discover, develop, and manufacture than traditional “pharmaceuticals.” It was nine years before Genentech achieved FDA approval for its first biologic, a growth hormone. But it was really in 2004 when Avastin and Tarceva were approved that Genentech’s true potential became apparent. Genentech now has a larger market cap than all but three U.S. pharmaceuticals–Johnson & Johnson, Pfizer, and GlaxoSmithKline.
The term biotech is now part of our everyday vocabulary. You know that the U.S. Food and Drug Administration (FDA) controls which drugs reach the market, and you’ve probably read about the potential impact of emerging technologies like stem cell research.
It’s an ironic twist that the intrinsic complexity of the biotechnology industry has served as the catalyst for the FDA to create a clearly defined process that makes it easier for us, as investors, to predict when inflection points in a company’s value will occur. All you need to do is follow the drug.
Follow the Drug
The fortunes of a drug company are directly tied to the success or failure of its new drug development programs. The steps for achieving that success are clearly defined by the FDA’s “clinical trials” process.
By knowing the milestones at which the FDA grants an “approval,” you can predict when an inflection point occurs. You can even predict the relative magnitude of the inflection, as we’ll see later. The Drug Lifecycle (see above) illustrates how a drug goes from a concept to a product and some of the terminology applied to the process.
The first step in drug development is called discovery. This is an unregulated process where the focus is on the science–identifying and testing potential drug candidates that the company believes may affect a particular disease. The company is attempting to confirm its theories by measuring the impact that 100s or even 1000s of molecules may have on the targeted disease. The hope is to identify one or more that show sufficient promise to proceed, thereby creating a “proof of concept.”
In the pre-clinical step, candidate drugs determined to be promising in the discovery step undergo testing in the laboratory and in animals to assess safety (toxicity) and demonstrate effectiveness (efficacy) on a preliminary basis. This is in support of the preparation of an Investigational New Drug (IND) application to the FDA, which must contain information about toxicology, manufacturing procedures, and plans for clinical testing in humans. Once the IND is approved, clinical trials can begin.
Clinical trials occur in three phases that may take up to 10 years and involve hundreds to thousands of patients. Each phase begins with the submission to the FDA of a specific plan for that phase, including the targeted results, called endpoints. The phase ends with the submission of the results to the FDA, which reviews and approves (or rejects) them. It may also request that additional testing be performed prior to issuing its final approval or rejection of the phase.
FDA Approval Criteria
The FDA’s approval of any drug is ultimately tied to two elements. One is efficacy–Does the drug work?–and the second is toxicity–Does it do harm?
There are varying degrees of each, of course, but it’s generally clear when a drug doesn’t work, that is, when its “outcome” misses its targeted “endpoint.” Potential endpoints to a clinical trial could be extending a patient’s life (survivability) or reducing or eliminating the occurrence, severity, or frequency of the symptoms.
Or a drug may work (that is, demonstrate efficacy), but causes an undesirable side effect, what the industry euphemistically calls “an adverse event.” An adverse event (or AE) can be anything from a minor headache to the most severe of adverse events: death. Nothing gets a drug killed faster than a death or worse yet, multiple deaths that are tied to the drug’s use.
If a drug safely meets its targeted endpoint(s), it passes. Recently, Genentech’s Avastin was acknowledged to have met its endpoint for the treatment of colorectal cancer by extending survivability 11.8 days. While one could argue that 12 days is not statistically meaningful, who of us wouldn’t want to take the chance that we might be one of the lucky ones whose life is extended longer than the average 12 days?
In Phase I of the clinical trials, the new drug is tested primarily for safety in a small number of patients, usually from 20 to 100 healthy volunteers. Some efficacy data may also be collected. Phase I typically lasts a few months to a year; about 30% of the drugs entering Phase I fail.